Friday, June 6, 2014

Mission Accomplished

(Full disclosure - we really like Mario Draghi)
Enter the Dragon - exit the Draghi 

By most accounts, the ECB lived up to expectations and delivered the alphabet without a hint of a stutter. TLTROs, ABS, MROs... his posture was strong, his breath was hot - his hair was perfect.  

If enhancements of the ECB's monetary policy transmission mechanisms were a concern, Draghi brought the thunder. If a weaker currency - which happens to be one of the primary measures to mitigate deflationary forces, was the goal - the markets brought the rain. 

On the day the ECB broke the ZIRP barrier and went where no central bank has ever gone before, the euro ended the day up 0.45%. If we were in a production studio on a satire news set, Draghi's briefing would have taken place on an aircraft carrier in the North Sea beneath a 200' "Mission Accomplished" banner.

For those of us that have viewed the European condition not as a conundrum - but more a reality, the market reaction witnessed yesterday came as no surprise. Jawboning only provides short-term
relief and trades the present for the future. Moreover, markets make significant pivots when positioning and sentiment become stretched at a relative extreme. It's nature versus nurture - and nature always has the last word. While Draghi has nurtured certain expectations in the market, the downstream effects only caused sentiment and positioning to build, that inevitably works against the ECB's intentions to weaken its currency.  

Throughout the system, markets are stretched at sentiment and position extremes. While conditions can maintain character longer than anticipated, we expect the inherent principles of Mother Nature will once again take the day. In three separate asset corners of the markets, we have been watching those conditions capitulate and converge. Although we had to move the guideposts in the yen (circa 2003) with Draghi's best intentions, the congruent EKG of Japan's perennial deflation still holds influence with us when evaluating the upside potential in the euro. Long story short - we still like the euro.    
While the euro is the latest conundrum to confound central bankers and participants alike, the real McCoy continues to unwind along the arc we expected. Maintaining the offsides nature of expectations in the market, this week's J.P. Morgan bond market survey had net shorts in long-term Treasuries at an eight-year high. Those are surprisingly dogmatic leanings, considering the average long-term Treasury portfolio has outperformed the SPX this year. 
Similar to the offsides market positioning present in the EURUSD, we expect silver to capitulate higher off long-term support that was tested over the past year.